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Financial Experts Examine Stock Market Irregularity

August 24, 2007 at 6:05 PM EST


RAY SUAREZ: It’s been a turbulent time on Wall Street the past few weeks, as investors tried to gauge whether turmoil in the financial markets was a passing storm or might have more far-reaching effects. Fallout from the surge of defaults in subprime mortgages led to a general tightening of money in all lending markets and eventually to a so-called “liquidity freeze,” where even borrowers with good credit histories find it difficult to secure loans. That triggered wild swings in the stock markets.

But this week, that volatility cooled, following last Friday’s announcement that the Federal Reserve Board had cut its interest rate on loans to banks, an effort to inject money into the financial markets. A further calming signal came Wednesday, when Bank of America invested $2 billion in Countrywide Financial Corporation, a company that funds roughly one in every six mortgages in the U.S. Those actions seemed to have had the desired effect, with the Dow holding steadily above 13,000 throughout the week.

For more on the Fed’s move and its effects on U.S. stocks and financial markets, I’m joined by James Angel, associate professor of finance at Georgetown University. He’s a specialist in financial markets. And Nicolas Retsinas, director of Harvard University’s Joint Center for Housing Studies.

And, Professor Angel, it’s been a week since the Fed intervened in the mortgage meltdown in the stock markets. Did it work?

JAMES ANGEL, Georgetown University: Yes. Even though it’s been quite a jittery week, we see the volatility is starting to fall, and markets seem to be getting back to normal.

RAY SUAREZ: And so this means the worst is over? What does it mean?

JAMES ANGEL: Well, we don’t know. We never know exactly what’s going to happen in the future, but the Fed did exactly what they were supposed to do. They saw a credit crunch starting to happen, and it’s their job to make sure that there’s just enough money in the U.S. economy — not too much, not too little — and they saw the credit crunch happening, and so they said to the banks, “Hey, we want you to lend money. We’re going to make it easy for you. We’re cutting our interest rates.”

And the banks made a very public show of coming in and borrowing from the Fed. They’re making it quite clear that they have the money available to lend.

Tracking new home sales

RAY SUAREZ: Professor Retsinas, today the new home sales number unexpectedly jumped for July, and the number of months of supply of new houses went down, which signals a little bit of tightening. Was this as unexpected as all that? And might this mean good news for months out from here?

NICOLAS RETSINAS, Joint Center for Housing Studies: Well, it was good news today. Any time that there are more sales of new homes, that means that inventories are reduced and you start to get some stabilizing in the market. Monthly figures, however, are notoriously volatile. So I think it's a little too early it take out the balloons. I think we're in for a long recovery period, and we're really just at the beginning of that.

RAY SUAREZ: Well, Professor Angel, this is variously been called a credit crunch, a credit crisis. Are there signs that money is not moving in the way that it was through the economy? And who should be worried about it?

JAMES ANGEL: Well, anybody who wants to get a loan should be worried about it, whereas...

RAY SUAREZ: For anything?


RAY SUAREZ: Not just for a house, but for a car and other things?

JAMES ANGEL: Yes, that's what a credit crunch means. A credit crunch means that even people with good credit have trouble qualifying for loans on reasonable terms, because what happens is the banks don't want to lend unless they're pretty sure they're going to get paid back. And in a time of uncertainty when they don't really know what's happening, they're going to stand on the sidelines and not want to lend to anybody.

RAY SUAREZ: And how does that syndrome, Professor Retsinas, express itself specifically in housing, if you want to buy a house, if you want to sell a house, if you already own a house and simply want to refinance your mortgage?

NICOLAS RETSINAS: Well, for some people, credit crunch probably understates it. If you are a borrower who has one of these subprime mortgages and is having difficulty paying it, almost by definition you are credit-impaired or else you wouldn't have been a subprime borrower. It's going to be especially difficult to find your way out of it to another mortgage.

If you're a borrower trying to buy a home that has loan limits higher than the loans that can be purchased by Freddie Mac or Fannie Mae, you're going to pay a lot more. All of this is going to continue to slow and lengthen the recovery. It's going to -- in the housing market, it's all about housing finance, and this credit crunch is squeezing housing finance.

Institutions' votes of confidence

RAY SUAREZ: Well, Professor Angel, why does it happen this way when the Fed intervened, when Bank of America, a very big institution, made a vote of confidence in Countrywide? Why aren't the nervous reassured by big movements like that?

JAMES ANGEL: Well, I think many of the nervous people have been reassured, but it takes time for people to regain their confidence. So they want to find out, OK, who has lost money in this subprime problem? And what is going to happen? So it takes a little bit of time for people to come back into the markets.

RAY SUAREZ: Even with risk spread the way we're told, that it was spread more widely now, that people bundling mortgages may have been exposed to a few more foreclosures, but because the paper went here and there and was held in a lot of different ways, no one actor could be hurt too terribly if a lot of people couldn't pay their mortgages anymore.

JAMES ANGEL: Well, if no one actor concentrated themselves on subprime paper. But what has happened is that -- and we will find out who very shortly -- there are some people who said, "Wow, we can make a lot of money on this subprime paper because it has a really high interest rate." So if somebody got too greedy and loaded up on too much subprime, then their credit is going to be impaired as a result.

RAY SUAREZ: Professor Retsinas, you talked about people wanting to refinance maybe facing a very tough time. May it be six months, nine months, a year before we even know how badly this bit the economy, because people miss a payment one by one, people panic in front of a balloon payment one by one, and we can't really see them all at once?

NICOLAS RETSINAS: Well, it will be time before we assess the overall and lasting impact on the economy. But unlike the investor side of the equation, at this end of the pipe, on the borrower side, risk is very concentrated. There are literally thousands of people losing their homes today, and they're not able to spread this risk. They're, in a sense, left onshore after this credit crunch, even after this credit crunch start to ease.

That's going to be the challenge is, how do we minimize that impact, at the same time trying to restore some sort of fundamental sense to lending in this country?

RAY SUAREZ: Politicians have already started to talk about those thousands of people who you're talking about who've had their exposure and their risk visited on them in a very substantial way. Do you expect that the federal government will come up with a response, that banks that don't want to be landlords, that don't want to be real estate brokers will come up with a response?

NICOLAS RETSINAS: Well, I think we're more likely to see the federal government come up with a response that talks about this never happening again, trying to put controls on lending. I think it's going to be very difficult and in part very expensive for the federal government to intervene -- to be seen as bailing out.

Now, saying that, there are a handful of states that are trying to raise pools of money. But even then, they're faced with a challenge: Are they helping people temporarily, or are they helping people who probably never should have got a loan in the first place?

The effects of the housing economy

RAY SUAREZ: Well, what's the effect, though, in the wider economy if a lot of people lose their homes in a very short period? You talked about those people having this crisis visited on them, but what do they mean in the aggregate, or in a town where a lot of it happens at once?

NICOLAS RETSINAS: Well, it is concentrated in certain areas. That is, it's not evenly distributed. And there are certain neighborhoods where you can see sign after sign of sort of foreclosures going up. That can be devastating on a neighborhood.

In terms of the broader economy, one of the important parts of families' wealth, particularly for moderate-income families, is their home. If they start getting nervous about the value of that home, that's going to have a deleterious effect and is certainly going to temper any consumer spending they do.

RAY SUAREZ: So I guess, Professor Angel, even people who aren't in danger of losing their homes may start feeling poorer at the same time and feel less inclined to spend money, as well?

JAMES ANGEL: Exactly. When we all saw housing prices going up during the housing bubble, we all had a feeling of, "Ah, I'm wealthier now." And so there's more of the temptation to think that, "Ah, yes, more is coming this way. We can spend more. Take out a home equity loan. Take out some of the equity in the house and spend it on something."

But with housing prices stable or falling, we no longer have that feeling of euphoria. Instead, there's a feeling of, "Oh, my. What's going to happen? How low will prices go?" And so there's a little bit of fear there. And when people are afraid, they tend to cut back. The real question is, what's going to happen as this ripples through the economy?

RAY SUAREZ: Would banks rather avoid taking a foreclosed property if there are a lot of people in foreclosure at the same time? Do they really want to hold foreclosed houses?

JAMES ANGEL: No, banks don't want to foreclose. Banks are not in the real estate business. The last thing they really want to do is be stuck with a house, because when somebody loses their house, chances are, if they haven't had the money to pay their mortgage, they haven't had the money to maintain the house. They haven't taken good care of it. So by the time it's foreclosed upon, it's probably in pretty bad condition.

And then they have to deal with all the costs of holding it, carrying it on the books, selling it. They know that whenever they foreclose on a property, they've lost money. So generally speaking, they don't want to foreclose, but they do it because they have to. It's their one stick to make sure they get paid back.

RAY SUAREZ: But if it's happening a lot -- very brief answer -- if it's happening a lot, will that change the relationship between the borrower and the lender? Will there be banks who are more willing to recast loans?

JAMES ANGEL: Well, the problem is the loans are no longer with your local banker. The local banker may have originated the loan but then sold the loan. And, yes, we've done a great job of spreading the risk all over, but then you find that the person who actually has the decision of what to do about that mortgage is located 3,000 miles away and generally doesn't have the flexibility or the insight to figure out an appropriate work-out for that loan.

RAY SUAREZ: Jim Angel, Nicolas Retsinas, gentlemen, thank you, both.


JAMES ANGEL: Honored to be here, thank you.